Wash Trading: How To Not Get Deceived By Market Manipulation
Wash Trading: The Epidemic of Crypto and NFTs
In the realm of finance, wash trading is not a new term to many. Before the era of cryptocurrencies and NFTs, wash trading was a fraud mechanism utilized by con artists to manipulate the market in their favor in hopes or turning higher profits and returns on their investments. In traditional financial markets, this type of activity has been banned entirely since 1936 when the Commodity Exchange Act was passed.
Now in the new unregulated era of Web3 we find ourselves in, this practice is becoming abundantly utilized by con artists throughout all ecosystems to inflate the value on their cryptocurrencies and/or NFTs. To put it bluntly, it has become an epidemic of fraud that manipulates data to misinform investors into making bad investments. But what is wash trading exactly?
What is Wash Trading?
Wash Trading is referred to as a form of market manipulation in which an individual buys and sells the same asset to themselves in hopes of inflating the value by manipulating the market data on the asset.
In the NFT space, wash trading is commonly defined as the act of an individual (or group of individuals colluding) selling and buying the same NFT in hopes of artificial inflating the value of the asset and with manipulated data and demand.
Why do People Wash Trade Their Assets?
1.) Artificially Inflating Their Investments
Because the crypto industry is so unregulated in contrast to other financial markets, wash trading has been a heavily popular mechanism utilized by con artists and greedy individuals to artificially inflate their own investments in hopes of a higher return. By purchasing their own NFT from themselves at a higher price than they originally purchased it for, this artificially inflates the value of the NFT in data analysis provided by marketplaces and/or NFT data analysis firms.
A very prominent example of this type of wash trading is none other than the $500 million sale of CryptoPunk #9998. On October 28th, 2021, the owner of this NFT sold it for nearly 125,000 ETH (around $532 million at the time of the sale) to a separate wallet they controlled. The individual then proceeded to transfer back all the ETH back to the wallet he purchased the NFT with and then listed CryptoPunk#9998 for 250,000 ETH (around $1 billion at the time of listing). Before the individual conducted the wash trading scheme, this asset was only trading for hundreds of thousands.
Another version of this form of wash trading is when an individual sends a very high offer on their own NFT with separate wallets creating artificial demand and value for the NFT to those who come across it. An example of this type of wash trading is shown below when a prominent NFT project on Cardano; Hosky, exposed an individual placing very high offers on their own Hosky Cash Grab NFT to artificially create demand and value.
Because the offers were listed automatically through a Twitter bot set up by Jpg.store, this individual utilized the publicity to artificially create a sense of demand within the CNFT space in hopes of manipulating someone into making a hasty purchase without realizing the external factors pressuring them. This type of wash trading is extremely effective because of its difficulty in proving the coordination between anonymous wallets causing it to unfortunately be utilized by con artists and unethical individuals.
2.) Producing Artificial Volume on Marketplaces For Rewards
Another utilization of wash trading is to artificially produce volume on marketplaces that offer rewards in the form of cryptocurrencies, NFTs, etc. Marketplaces like LooksRare and X2Y2 offer their users rewards in exchange for utilizing their marketplace by selling/buying NFTs.
Because of the difficult of receiving these rewards in abundance by simply buying and selling NFTs legitimately, those looking to recieve as many rewards as possible utilize wash trading to artificially pump the volume on their addresses to produce higher rewards distributed by these platforms.
In the graphic above, the same NFT was purchased and sold between the same wallets multiple times in a single day totaling 7,228 ETH in transactions while paying a mere 36.14 ETH in platform fees to earn a plethora of rewards from the NFT marketplace, X2Y2 (this platform shares 100% of its revenue with token stakers).
This form of wash trading is heavily popular with analytical firms like Footprint Analytics stating that over 95% of volume on the top collections of platforms like LooksRare and X2Y2 are wash trading transactions. This is a severe concern for the NFT space as it artificially pumps volume and demand for these collections manipulating individuals with a false sense of urgency. It also completely disrupts the historical data for an NFT project as they become bombarded with fraudulent or misleading transactions.
3.) Laundering Ill-Gotten Gains
Unfortunately in the art space, money laundering has always been a highly prevalent issue as art pieces are very easy to liquidate and are very subjective to pricing. Criminals and fraudsters have utilized this tactic for decades by purchasing art pieces with ill-gotten money with plans to sell the asset later in the future in hopes to launder the money and remove the connection to the criminal activity that raised the money in the first place.
Now in the cryptocurrency industry and NFT space, con artists and fraudsters have utilize these ecosystems to launder billions of illegally obtained funds. Although these ecosystems always provide a very public and transparent ledger, it has not deterred con artists from wash trading assets in hopes to self-launder their funds. But none other aspect of this industry has been impacted more by money laundering than the NFT space, where individuals self-launder their ill-gotten gains by purchasing an NFT from themselves using separate wallets. Because NFTs are volatile and subject to less scrutiny from regulators and law enforcement.
How To Detect Wash Trading
Although there is no concrete method to investigating wash trading transactions, there are a plethora of tips that can help deter yourself from making poor decisions based on artificial data, volume, and demand:
1.) The NFT is bring purchased often in comparison to the entire NFT collection: If you’re looking at a specific NFT and it is being purchased a lot more frequently than most NFTs in the collection, it may be best to wait it out and not take the chance of being manipulated by artificial data.
2.) The NFT is being purchased and sold by the same two addresses: If you are looking at a specific NFT, make sure to check the history of its sales and ensure it has not been sold by the same wallet(s) a number times. This is a common tactic to artificially raise the value of the NFT.
3.) The NFT is being purchased and sold for an extremely high price in comparison to the entire NFT collection: If you come across an NFT that is being sold for extremely high prices relative to the floor price, it could be a result of an individual selling the same NFT over and over to themselves artificially raising the value, volume, and demand.
4.) The NFT has been purchased far more often on a specific marketplace for higher prices: Another way to detect wash trading is viewing the trading history of a specific NFT on several marketplaces as individuals will wash trade on a specific marketplace to then list it on an alternative one. Please note this tip is not as concrete as with ecosystems like Cardano; the NFT space is predominantly facilitied by one marketplace, Jpg.store.
5.) An NFT collection is minting at an abnormally fast rate without sufficient marketing: Another form of wash trading is when a project will self-mint their assets overtime reducing the available supply in hopes to artificially pump the price of their assets or sell out quicker. If a project seems to be minting very quickly without real marketing, recognition, or effort; it may be due to a scheme constructed by the project’s team.
Although this checklist aims to serve as a means to educate individuals on such practices, as stated above this does not serve as a concrete method of detecting wash trading as there are many outliers or exceptions.
What Needs To Change
In the context of NFTs, wash trading could potentially mislead buyers into believing that an NFT has more value or demand than it actually does, leading to financial losses for those who purchase the NFT based on falsified information. Additionally, wash trading can erode trust in the market and undermine the integrity of the industry as a whole. Therefore, it is important for market participants to be vigilant in detecting and preventing wash trading, in order to protect both themselves and the broader NFT market.
The harsh reality is that wash trading is an epidemic completely disrupting the NFT space with artificial data, volume, and trading history that completely destroys legitimacy to historical data of nearly all collections. Real reform within the NFT space needs to occur promptly, reform like mandatory KYC protocols for any and all NFT marketplaces to hold fraudsters accountable for their actions.
Wash Trading has been illegal for nearly a century for all securities and commodities; but with the lack of regulation in the NFT space, wash trading NFTs is a very tricky and complicated legal debate. One can only hope reform can be achieved with a consensus established by legislative bodies and the ecosystems in which this debate is centered around. Together; and only together, can this industry truly tackle these issues.
